NEW ERA ECONOMICS Edited by Tony Dolphin and David Nash August 2012 © IPPR 2012 Contributions by John Kay \ David Nash \ Amna Silim Paul Ormerod \ Michael Hallsworth Greg Fisher \ Geoffrey M Hodgson \ Tony Dolphin Stian Westlake \ Jim Watson \ Pauline Anderson Chris Warhurst \ Sue Richards \ Eric Beinhocker Orit Gal \ Adam Lent COMPLEX NEW WORLD TranslaTing new economic Thinking inTo public policy Institute for Public Policy Research COMPLEX NEW WORLD Translating new economic thinking into public policy Edited by Tony Dolphin and David Nash August 2012 i ABOUT The ediTOrs Tony Dolphin is senior economist and associate director for economic policy at IPPR. David Nash is a policy adviser at the Federation of Small Businesses and was until recently a research fellow at IPPR. AcknOwledgmenTs This book is published as part of IPPR’s New Era Economics programme of work. We would like to thank the Barrow Cadbury Trust, the Esmee Fairburn Foundation and the Joseph Rowntree Charitable Trust for their support of this programme. ABOUT iPPr IPPR, the Institute for Public Policy Research, is the UK’s leading progressive thinktank. We produce rigorous research and innovative policy ideas for a fair, democratic and sustainable world. We are open and independent in how we work, and with offices in London and the North of England, IPPR spans a full range of local and national policy debates. Our international partnerships extend IPPR’s influence and reputation across the world. IPPR 4th Floor 14 Buckingham Street London WC2N 6DF T: +44 (0)20 7470 6100 E: [email protected] www.ippr.org Registered charity no. 800065 August 2012. © 2012 The contents and opinions expressed in this book are those of the authors only. ii IPPR | Complex new world: Translating new economic thinking into public policy cO nTenTs John Kay Foreword ..............................................................................................1 About the authors .................................................................................3 David Nash Introduction ..........................................................................................7 Part 1: An overview of new economic thinking 1. Amna Silim What is new economic thinking? .........................................................18 2. Paul Ormerod Networks and the need for a new approach to policymaking ...............28 3. Michael Hallsworth How complexity economics can improve government: rethinking policy actors, institutions and structures ..............................39 Part 2: Policy 4. Greg Fisher Managing complexity in financial markets ............................................50 5. Geoffrey M Hodgson Business reform: towards an evolutionary policy framework ................62 6. Tony Dolphin Macroeconomic policy in a complex world ..........................................70 7. Stian Westlake Innovation and the new economics: some lessons for policy ...............82 iii 8. Jim Watson Climate change policy and the transition to a low-carbon economy .....95 9. Pauline Anderson and Chris Warhurst Lost in translation? Skills policy and the shift to skill ecosystems .......109 10. Sue Richards Regional policy and complexity: towards effective decentralisation ....121 Part 3: Politics 11. Eric Beinhocker New economics, policy and politics ..................................................134 12. Orit Gal Understanding global ruptures: a complexity perspective on the emerging ‘middle crisis’ ....................................................................147 13. Adam Lent and Greg Fisher A complex approach to economic policy ...........................................161 iv IPPR | Complex new world: Translating new economic thinking into public policy FOrewOrd JOhn kAy History teaches us that major economic crises usually lead to a period of soul searching followed by a radical rewiring of economic policy. The 1929 stock market crash and subsequent depression saw classical economic thinking gradually give way to Keynesian central planning. The onset of stagflation in the 1970s ushered in neoliberalism and the advent of market deregulation. The 2008 financial crisis and ongoing recessionary fallout in most advanced economies would appear, on the face of it, to represent a similar historical turning point. Each of these crises called into question the credibility of conventional economics. Economists have never enjoyed a good reputation and 2008 marked a new nadir for the profession. However, we have yet to witness a radical transformation in economics of the sort that accompanied past upheavals. The policy options being debated today are largely an extension of past arguments that occurred in 1929 and 1970. Whether fiscal austerity versus growth or supply-side reforms versus demand stimulus measures, the positions of the leading players are entirely predictable and rest on established political allegiances. The opportunity for radical policy change is gradually fading. A crisis is going to waste. While public policy debates make little explicit reference to economic theory, Keynes’s comment that ‘practical men, who believe themselves exempt from any intellectual influence, are generally the slaves of some defunct economist’, is as true as ever. The rational choice models and general equilibrium theory that were developed in the 25 years after the second world war fed into the neoliberal policymaking of the quarter century that followed. These approaches remain the dominant academic paradigm, especially in finance theory and macroeconomics. They describe a world in which economic agents are rational, informed and make optimal decisions, and markets are either in, or geared towards, a state of equilibrium. Governments should, it is suggested, design economic policy on this basis. Differences between left and right turn on the narrow issue of the extent of ‘market failure’, a narrowly defined categorisation of legitimate reasons for policy intervention. The chief assumptions behind economic policymaking on the left and right are largely the same. The simplifying assumptions of an abstract theory are treated as universal truths about the real world. 1 But there are many alternative insights into economic phenomena. New economic thinking provides us with a far richer account of the economy, taking into account real-world human behaviour and the complex micro-level interactions that make up economic activity. Complexity, evolutionary and network economics are emerging fields of inquiry that offer a robust critique of neoclassical theory. They reject the latter’s deference to static equilibrium and perfect rationality, ignorance of innovation, downplaying of institutions, and assumption of zero-sum market transactions. They depict instead an economy made up of millions of overlapping activities, in which individuals, businesses and other institutions are highly connected and constantly interact, where preferences change and markets shift in unpredictable ways. It is a description that is immediately more recognisable in reality. While nods in the direction of behavioural economics have become fashionable, these ideas have received scant attention in policy circles. The market failure doctrine remains the required framework of microeconomic debate. Macroeconomic forecasting and analysis in the Treasury, the Bank of England and the Office for Budget Responsibility still draws on dynamic stochastic general equilibrium (DSGE) models and other staples of conventional economics. The majority of government economists and policymakers responsible for providing solutions to the most important economic challenges of the day – how financial instability might be tamed, how regional development can be boosted, and how the carbon emissions and other environmental side effects of economic growth can be reduced – are heavily influenced by the old neoclassical order. This must change. This book – which is the culmination of a two-year programme of work led by IPPR entitled New Era Economics, on whose advisory panel I have been a member – is the first serious attempt to bring insights from new economic thinking to policymakers. It draws together contributions from a group of respected economists and academics, which discuss what these new heterodox economic theories might mean for policy. In so doing, it is an attempt to kick-start a much-needed debate about how economic policymaking can be improved for the better. Changing the nature of mainstream economics will be no straightforward task. Yet if we do not take advantage of the current crisis to rethink the way we make economic policy, the opportunity will be missed. We need a far more eclectic approach to economic policy and economic debate. Thankfully, there is a solution and it lies in new economic thinking. This book sketches out the contours of a new approach to economic policymaking centred on this thinking. For that reason, it deserves a wide readership. 2 IPPR | Complex new world: Translating new economic thinking into public policy ABOUT The AUThOrs Pauline Anderson is a research fellow at the Centre for Research in Lifelong Learning, Glasgow Caledonian University. Her research lies in the areas of skills policy and contemporary labour market issues. She has a particular interest in intermediate occupations, the youth and graduate labour markets, skill ecosystems, and jobs growth and skills in the renewable energy industry. Pauline also manages a programme of internal institutional research currently focused on widening participation, progression and